Video Update: Don’t Get Swayed By This Insane Market

The tech sector is on another tear.

Spurred by the game-changing potential of artificial intelligence (A.I.), many are piling in to capture some of the profits.

But there are a few things investors are missing in their eagerness.

In today’s video update, Chief Analyst Adam Galas breaks down the complex variables at play in today’s market… and why everything is not as it may seem.

At Fortress Portfolio, our focus is on generating wealth over the long term. That’s why if you find yourself being swayed by today’s short-term moves, make sure to check out today’s update.

Click below to watch the video or read the transcript.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome Fortress Portfolio members to another weekly update.

Today we're going to answer two subscriber questions and start a two-part miniseries about staying safe and sane during insane times.

And I want to make this clear. We are living in some insane times.

Look at Tesla as an example. It is up an incredible 35% after going up 12 days in a row.

This is absolutely insane.

In May, Tesla was up 24%.

And that wasn't even the best tech stock that month.

Nvidia (NVDA) was up 36%. And C3 was up 125%.

Now, I should note C3 is a software service company that initially started out calling itself C3. Then in 2008, when oil hit $150 (and oil was all the rage) it changed its name to C3 Energy.

Then a few years later, when the internet was all the rage, it changed its name to C3 loT.

And now A.I. is the next hottest thing so they changed their name to C3 AI.

You can see how changing your name, just like companies did during the tech bubble to “.com”, can pay dividends in the short term as far as soaring stock prices.

But this irrational enthusiasm over A.I. has gone completely insane.

For context, Sun Microsystems CEO said on an earnings call back in 1999 that 10x sales was an insane valuation to pay for even the fastest growing companies.

Well, Nvidia is now close to 40x sales and on a trailing basis, over 200x earnings.

Remember, trees don't grow to the sky as the saying goes, not even thanks to A.I.

Now, yes, artificial intelligence is likely to be a game changing and world changing technology.

Goldman Sachs (GS) estimates that it will boost long term productivity and economic growth by between 0.3% and 2.9%, with a base case of 1.5%. And as we saw last week, could solve approximately 94% of America's long term deficit problem all on its own.

However, that's over the long term.

In the short term A.I. is not doing anything for productivity.

Now, productivity is measured by dividing how much Americans spend – GDP – by how many hours Americans worked.

U.S. productivity has dropped for five straight quarters, with the last report showing a -0.8% decline.

This is the longest slump in productivity since the government started collecting this data in 1948.

There are only two ways to look at this. Either U.S. workers have become some of the least efficient in the world, or our economy is shrinking.

It is due to a combination of potentially negative economic growth, labor hoarding, and work from home.

It's a very complex issue.

But here's the bottom line. We are headed for a recession.

We may already have been in one for the past six months.

But even if we’re not, State by state job loss claims are currently at a level that has never before happened without a recession starting soon afterwards.

If we look at 18 economic indicators, we can see both the average and the leading indicators.

If you look at the chart in my video above, the red and blue dots are at historically low levels or slightly below trend.

But more importantly, they're decreasing at an annualized rate of between 10% and 17% per year.

So what does that actually mean?

Well, historically speaking, when the economic indicators are at their current levels, it means we're around two weeks away from the start of a recession.

Now, again we might already be in a recession, and possibly have been for as long as six months.

That's because if we look at the gross domestic income (GDI), which keeps track of all the money earned in America something is off in comparison to another data point, our GDP.

Now, gross domestic product (GDP) is the amount of money spent in America over a certain period. It is also the number the government uses to figure out how big our economy is.

Because one person’s spending is another person’s income, GDP and GDI usually match up.

But not lately. GDI dropped almost 4% in the fourth quarter of 2022 and just over 2% in the first quarter of 2023.

And the average of both GDP and GDI, which some experts think is the best way to measure economic growth, has been negative for two quarters in a row.

But in the pandemic, things got topsy turvy.

So what does this actually mean?

How is it possible that we could be in a recession if we just had a blowout jobs number? We were told 339,000 jobs were created in May.

Well, don't get too excited because in that same government report, the household survey (how the government measures unemployment) showed 400,000 net job losses compared to 340,000 gains.

And, that's the difference between 4.4 million jobs created in 2002 and the same monthly job loss rate as the Great Recession.

A pretty big difference.

So has there ever actually been a recession in which jobs were climbing, at least initially?

Well, yes. In 1973, this occurred, and it happened because of high inflation.

Revenues for corporations were actually climbing at that time so companies were still hiring for the first eight months of the recession.

Well, then suddenly job losses mounted. The economy really turned over and stocks ended up falling 54%.

Now, I want to make this very clear. I am not a doomsday prophet.

I am not a perma bear.

The stock market is always climbing a wall of worry.

For the last hundred years scary headlines have always been present, which is why doomsday prophets like Robert Kiyosaki are always in business.

In the last ten years, he’s been predicting 90%+ market crashes.

Jon Huntsman has been predicting 70% market crashes for the last ten years.

And Jeremy Grantham, the elder statesman of the perma bears, has been predicting 50% market crashes for the last decade.

Well, that is not justified by the data or the fundamentals.

But I am here to tell you that what we're seeing now is insanity.

This is an A.I. tech bubble that will eventually end in tears, probably sooner rather than later.

And next week in part two, we'll take a look at why this A.I. bubble mania makes so little sense. We’ll also cover what the stock market is likely to do in the coming months.

But now let's take a look at two subscriber questions.

First, we have Christopher saying,

Well, this is a great question, Christopher.

I’ll answer part one first: Is PQTAX is a mutual fund or ETF?

PIMCO TRENDS Managed Futures Strategy Fund (PQTAX) is a mutual fund. You can think of managed futures as hedge funds that use options trading to go either long or short on stocks, bonds, currencies, and commodities.

We selected it specifically because it is historically the lowest volatility managed futures fund that is five star rated by Morningstar (at least in the low cost institutional version).

But also in our Fortress Portfolio is PIMCO 25+ Year U.S. Treasury Index Exchange-Traded Fund (ZROZ), which is an ETF.

Part number two: Are there any alternatives to PQTAX worth considering?

There are lots of alternatives in managed futures.

Now, because of the banking crisis, which triggered the largest bond market rally in 42 years, the industry was hit like a bombshell and is just starting to recover.

Now there are four ETFs worth considering.

The first is iMGP DBi Managed Futures Strategy ETF (DBMF), the Vanguard of managed futures. This tracks what's called the SG CTA index, which is the 20th largest managed futures fund. It includes PIMCO, AQR Capital Management (AQR) and AlphaSimplex (ASFYX).

Now, an intriguing idea for the long term (though still speculate for now) is Return Stacked Bonds & Managed Futures (RSBT) ETF.

RSBT tracks the SG CTA trend following the index, which historically does a little bit better than DBMF’s index.

And on top of this, stacks are 100% bond exposure via options. So historically, this strategy has delivered around 11% to 12% returns since 2000.

Of course, with the bond yields currently trading like crypto, it's poorly underperformed in comparison to its peers.

Now I'm reasonably confident (that's why I own a little bit that it) that it will do a lot better in the future.

But I would certainly not replace PIMCO (either PQTAX or ZROZ) with RSBT right now for one other important reason.

Remember that this is a trend following strategy it's using. And right now stocks are red hot.

That's why some of its largest positions are long the Nasdaq and long the S&P.

Well, if the market rolls over quickly in a recession, which certainly is the expected outcome. Then RSBT is likely to underperform in comparison to peers.

There is also the Simplify Managed Futures Strategy ETF (CTA), which is a relatively new managed futures ETF. It doesn't use stocks, just bonds, interest rates and commodities. So it has less correlation to the stock market.

Now it is more volatile as we saw during the banking crises after Silicon Valley exploded and the bond market had the mother of all rallies. CTA fell 18% in five days.

So just be aware that if you're interested in this ETF, which is the only one that pays monthly dividends, then you have to be prepared for that kind of volatility.

Finally, another one I like is KFA Mount Lucas Managed Futures Index Strategy ETF (KMLM), which tracks the Mount Lucas Managed Futures Index, which has been around since 1988.

Now, the nice thing about KMLM is that it only tracks 22 commodities, interest rates and bond option strategies. No Stocks. So it has the most negative correlation with the stock market.

And since 1988, it's index has delivered 9.4% annual returns. And after fees (had it existed back then), KMLM would have delivered 8.5% returns.

That's about twice that of its peers and twice that of bonds.

But, be aware that this has higher volatility than PIMCO, which targets around 11% annual volatility.

KMLM has about 17% annual volatility, and its biggest decline was in their worst bear market in industry history. Between 2016 and 2019, it saw a 28% decline.

So even hedges will at times deliver poor results.

You have to remember that basically managed futures are trend followers.

So in a recession, in a bear market, and in 2022’s recessionary stagflation bear market, there are lots of trends for them to follow.

That's when they shine and that's where they have the most power.

Next, I want to revisit a question from Gene asking why we use 30% hard stops and not something else like 20%?

We did answer Gene’s subscriber question in detail in the May issue, but here is a short explanation for those who missed it and are still wondering.

The performance of 44% of all U.S. stocks since 1980 has been catastrophic. And in the paraphrased the words of J.P. Morgan, permanently catastrophic, with 70%+ declines.

And for tech, it's been 59%. And for energy, 65%. So a trailing stop, which is what most of our services use, is designed to lock in profits before the we become another catastrophic statistic.

A hard stop is designed to keep you from owning one of these crappy companies that can basically doom your retirement dreams.

So why not less than 30%? Why not 20% or 25%?

Well, take a look at Johnson & Johnson (JNJ) as an example. JNJ is a AAA-rated dividend king. A company that is over 100 years old and almost certainly will outlive us and our grandkids.

But it has fallen 20 to 25%, several times over the decades.

So if you used a hard stop of 20% to 25%, then depending on when you bought it, you risk taking a completely unnecessarily loss.

Now, let's consider the 70% catastrophic scenario. How much does a stock have to fall to decrease 70% if it's already fallen 30%?

The answer is 53%. Or to put it another way, if your stock falls 30%, it has to fall another 53% to fall 70%. And remember, nearly half of all stocks will do that and never recover.

That's what the hard stop is designed to avoid.

Now, combined with prudent risk management, such as our 4.6% position sizing… Even if we get stopped out, as we did with Highwoods Properties (HIW) and Kilroy Realty Corporation (KRC), we only lose 1.2%.

And that's something that our dividends can recoup in just six weeks.

And let's not forget that we also have profits that I highlighted in last month’s issue.

We sold Magellan Midstream Partners (MMP) for a 25% profit, which recouped all the cumulative losses from HIW, KRC and V.F. Corp (VFC). VFC was a 2.7% loss, which we sold when it cut its dividend and broke our safe investment thesis. Well, we recouped that by almost 10x when we sold MMP.

That's the power of prudent risk management.

Please remember to send us your questions and comments so I can respond to them in these videos and our monthly issues.

Just remember, I can't legally provide individualized investment advice.

Thank you for joining us this week and I hope you join us next week for part two of staying safe and sane during insane times.

Until then, this is Adam Galas, wishing you and yours safe investing and a healthy and relaxing week.